If you have looked at a broker’s short term report or daily trading report, you will find a section on pivot points trading. What exactly are these pivot points and how to do intraday trading using such pivot points. Remember, pivots are based on the concept of supports and resistance and hence it is a technical measure. But pivots only work in the very short term i.e. either for intraday or for a trade of 2-3 days. In fact, in pivot point trading, the less overnight risk you take upon yourself, the better it is.
What exactly is meant by a pivot point?
Pivot point, as we mentioned earlier, is a technical indicator which is popularly used to determine the overall trend of the market across different time frames. Mathematically, the pivot point is nothing but simply the average of the high, low and closing prices from the previous trading day. The interpretation of pivots is also quite plain vanilla. On the next trading day, if the stock or index trades above the pivot point it hints at bullish sentiments, but if it trades below the pivot point it is a signal of bearish sentiments.
Pivot point trading is normally done with other supporting indicators like supports and resistances as they give you a better hang of where to put your stop loss and where to set your profit targets. Pivot points, actually, help traders see where the price could experience support or resistance. Essentially, pivot point trading can be applied two ways; using pivot points to trade in a range and using pivot points to trade breakouts. Let us look at both these options individually.
How to use pivots to trade in a range bound market?
The basic approach is quite simple. When price is trading above the pivot point, it indicates the day is bullish or positive. On the other hand, if the price is trading below the pivot point, it is a bearish signal. Pivot points go a step beyond plain vanilla support and resistance levels and include four additional levels: S1, S2, R1, and R2. These are used to represent support one and two, and resistance one and two. Support and resistance 1 and 2 could cause reversals, but they can also be used to confirm the trend (up or down). For example, if the price is falling and moves below S1, it helps confirm the downtrend and indicate a possible continuation to S2. A similar logic can be applied to the two levels of resistance viz. R1 and R2 also. In fact, pivots are extremely effective in trading range bound markets.
How to use pivots to trade market breakouts?
This point needs to be understood in greater detail. For example, if a stock has been taking support at a certain level and this level has now been breached with volumes, then the underlying trend of the stock becomes bearish. In that case, the basic strategy should have changed from “buy on dips” to “sell on rises”. Just as pivot points can confirm supports and resistances; pivot points can also be used to confirm upside breakouts and downside breakouts. The utility of pivot trading is not only restricted to equities and indices but can also be applied to currencies and commodities. For example, more often a stock or an index touches a pivot level then reverses, the stronger the level is. This applies to supports and resistances. When you get such confirmation from the pivot points, it is time double your bets as a trader.
Let us look at how to use pivots to trade breakouts. Breakouts are abnormal in that they represent a new direction for the stock. Breakouts are important because stocks will not remain in a range always. A breakout can happen above a resistance, in which case you must go long on the stock. Alternatively, a breakout can also happen below a support, in which case you can go short on the stock. So how do you trade a breakout using pivots? Broadly, you can use one of the ways to trade breakouts viz. aggressive way or conservative way.
Trading breakouts: aggressive approach versus conservative approach
As a trader you can opt for either of the methods to trade breakouts. The essential difference is that in a conservative approach, you wait for the confirmation whereas in an aggressive approach, you actually estimate the trend based on data and take a view even before the confirmation. Either method will work just fine.
Conservative approach to trading breakouts entails waiting for pivot confirmation before entering into a trade. This is the safer way and is less vulnerable to trading errors. At the same time, it also means that you could miss out on opportunities.
An aggressive approach to trading breakouts can also be done with the help of pivot points. This approach is all about estimating potential breakouts based on past patterns. Here you stand a better chance of catching the breakout in advance and positioning yourself according. Of course this approach is more vulnerable to mistakes.